Fitch Ratings-Jakarta/London/Singapore-31 July 2013: The lapse of the agreement for Singapore's DBS to buy a majority stake in Indonesia's Bank Danamon highlights challenges in the regulatory environment, which may deter foreign interest in Indonesian banks, Fitch Ratings says. DBS was only able to obtain regulatory approval for a 40% stake, lower than its intended 67%. This could limit potential buyers of Indonesian banks to investors with less commitment to the country and who may be looking essentially for capital gains.

Bank Indonesia's decision to approve a lower-than-intended shareholding sets a precedent of only a limited chance of gaining majority control of an Indonesian bank. Rules on bank ownership introduced in 2012 limit holdings in local banks of up to 40%, although there is regulatory discretion to lift this cap. Bank Indonesia was reported to be willing to consider increasing the ownership limit, depending on reciprocity from the Monetary Authority of Singapore such that major Indonesian banks can expand in Singapore. We believe the collapse of the deal is likely to discourage some long-term foreign buyers looking to establish and build a local franchise.

The ownership restriction would have impeded DBS's ability to steer Danamon's strategic direction and risk appetite. The Singaporean group's corporate governance procedures place an emphasis on a high degree of management control regarding its major operations, including the existing overseas markets and prospective investments as it seeks to build a sustainable pan-Asian franchise. Owning only a minority stake in Danamon would have rendered DBS less likely to achieve the same degree of integration in Indonesia as with its core subsidiaries elsewhere in the region.

The sheer size of the transaction's value would also have resulted in a less-optimal use of capital for DBS. A stake of anywhere between 10%-50% needs to be deducted from common equity, subject to certain thresholds, under the Basel III capital rules.

We have previously stated that we expect Singaporean banks to stay vigilant over emerging risks as they expand their regional franchises - particularly in less-developed economies. We believe DBS's decision to walk away from the transaction reflects the reduced economic benefits from a minority stake and the group's cautious risk appetite.

DBS's medium-term focus in Indonesia is still likely to remain on large corporates with regional needs. Indonesia as a whole remains an attractive banking market. The country has low credit penetration relative to other fast-growing markets (India and China), an expanding middle class, a resilient economy, and high net interest margins. The cap on Indonesian bank ownership of up to 40% is still high by regional comparison. But foreign capital is necessary for the market to fulfil its potential; and can also bring better risk, transparency and governance discipline to the banking sector.

DBS announced its intention to acquire a controlling stake in Danamon in April 2012, and received regulatory permission from Bank Indonesia to acquire a 40% stake in May 2013, with the possibility of getting approval to increase this investment. DBS's agreement with the seller lapsed today.